Many of the biggest and most prominent institutional investors and fund managers are at the forefront of a strong campaign to apply environmental, social and corporate governance (ESG) principles to their capital allocation requirements. As long-term resource owners, they understand a mandate to examine whether the businesses they own today can sustain a strong partnership with both their clients and extended populations, as environmental and social issues profoundly affect the way we live and operate. They also acknowledge that businesses that are committed to solving these pressing problems will be able to realise larger growth prospects in the future—and thereby generate better returns on their long-term shareholders.
Hence, there’s no doubt that sustainable investment is at the forefront of business goals in our times and will continue to gain prominence. In this article, we will discuss how sustainable investing is shaping the future of finance and why companies should consider availing ESG consulting services to enhance their portfolio.
What is sustainable investing?
Sustainable investment points at the realisation that businesses that solve the world’s greatest problems will be in a better place to prosper. It is about pioneering better ways of doing business and building traction to inspire more and more people to vote for the future society that we are trying to build.
In order to build a prosperous environment for ourselves and for future generations, the 2018 report of the International Commission on Climate Change reported that we would reduce greenhouse gases by 45 per cent by 2030 and reduce total CO2 emissions to zero by 2050. This is the best way to minimise global warming to 1.5 degrees Celsius.
More people are living longer, which ensures that more of our future will be influenced by the way our nations are managed, the state of our climate and the well-being of the people there.
In 2015, the United Nations laid out 17 Sustainable Development Goals (SDGs) to solve these big issues on a global scale. 193 UN countries have signed this agreement and it is the basis for the rise of sustainable investment.
The rise of ESG
There has been rapid growth in sustainable investments in the last few years and ESG has become extremely prominent. Investors consider the ESG rating of companies and accordingly make decisions. But, what is ESG and what factors do investors actually consider?
A Harvard report recently indicated that businesses with positive ratings on sustainability issues most important to their businesses have substantially outperformed companies with bad ratings on these topics.
Why sustainable investing is no longer a niche subject
To prevent or minimise the events listed above, investors recognise that they should no longer regard sustainable finance as a niche activity. Asset managers are now gradually moving away from policies aimed at avoiding risk by removing individual stocks in favour of tactics aimed at helping firms that do well on ESG issues. Examples include best-in-class and thematic investment; investment effects, such as low-carbon indexes and green bonds; and businesses that perform high on gender equity.
However, this is just the beginning. Soon, we are expected to see sustainable finance turn into a more cohesive and deliberate solution. With an aim to improve their risk and return performance, investors can make use of ESG automation and high-quality analysis for all their asset categories. Active ownership will now become an embedded model, with activists regularly working with boards and CEOs in the initiatives of corporations to improve diversity and resolve their environmental efficiency, much as they do now in the fields of executive pay, corporate governance and shareholder rights.
The guiding force behind these changes is the increasingly vital role that private-sector businesses can play in tackling climate change, diversity and other critical social issues—with major investors moving them down this positive path. However, turning this investment approach into concrete financial benefits for shareholders, both in the short and long term, needs insight into the measures that businesses must take to improve the impact and viability of their business models. Hence, many businesses are opting for ESG consulting that can help guide them.
Drivers of sustainable investing
Why is sustainable investing becoming a mainstream form of investment? What is powering the explosive growth predicted by analysts? The response lies primarily in maintaining high demand from investors around the board. At the same time, the factors driving this demand will vary considerably among various categories of investors, that can broadly be categorised as the following:
Millennials are ruling the private investment niche
The millennial generation, also known as Generation Y (birth years: 1981-1996), will play a major role in generating demand for sustainable financial goods and services. As they are intrigued by modern ways of investing, they prefer to invest in line with their values.
According to Morgan Stanley’s report, millennials are twice as likely to invest in businesses with major beneficial social or environmental effects as other buyers.
Awareness of institutional investors
A 433% rise in sustainable investment would not be reached without a substantial demand from institutional investors. In fact, some huge investors have become influencers in this space, while opting for investments that promote ESG values. Interestingly, there is more emphasis on sustainability for investors with larger portfolios, i.e. USD 100 billion or more (Schroders, 2018).
Measuring the impact of sustainable finance
The TSI, also known as Total Societal Impact is a framework that businesses and analysts use to determine the influence of shareholder returns and societal impact. A good example of this is BSG. The company made use of this framework to determine their success on implementing ESG values, while analysing sector valuations and margins. This shows that ESG values and impacts play a huge role while estimating the business values of companies in various industries.
It’s also important to note that investors compensate top performers of ESG with multiples from 3% to 9% higher than other companies that were equal to median performers. Best performers on certain topics have margins of up to 12.4 percentage points higher.
This comparison is expected to become more drastic over time, as environmental issues in many businesses are heading closer to the bottom line.
The perfect example of the changing industry scenario is when Pacific Gas & Electric (PG&E) filed for bankruptcy due to the unfortunate California wildfires. They cited climate change as the most prominent cause for the appeal. That was the first time that climate change had been directly discussed in this way.
The financial ecosystem—clients and staff, owners and stakeholders—is searching for growth and intent. Environmental, social and governance (ESG) issues remain at the centre of financial decisions, backed by the Sustainable Development Goals (SDGs) and improved climate emergency understanding.
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